Monetary policy by other means: Part I

This analysis was featured in Critical State, a weekly foreign policy newsletter from Inkstick Media. Subscribe here.

In the same way that an army marches on its stomach, a country fights on its economy. Napoleon knew something about both — in addition to maybe apocryphally coining the stomach line, he established the Bank of France in January 1800 in an effort to settle French finances as he prepared to lead his armies across the Swiss Alps and into Italy. Yet, like Napoleon in St. Helena, the work of central banks has largely been banished from popular discourse about security. This week and next on Deep Dive, we’ll look at research that aims to bring it back in by examining the effect that central banking can have on conflict.

Related: How do ‘whole-of-government’ programs actually work? Part I

In a new article in the Journal of Peace Research, political scientist Carolina Garriga digs into the role of central banks not in conquering new lands but in consolidating power in a country facing a civil war. A civil war, like any other kind, requires financial resources for a state to win. Moreover, civil wars are uniquely costly in that they inherently involve people and places that, in peacetime, would contribute to the country’s economic output. Civil war burns a country’s economic candle from both ends, as the state and insurgents alike draw on local resources to supply their war effort. Garriga is interested in how the structure of central banks affects the state’s capacity to generate resources to fight and win in civil wars. Specifically, she asks, does central bank independence impact how long civil wars go on?

In Garriga’s telling, central bank independence — that is, the appointment of technocratic bankers who are not directly accountable to the elected government to make decisions about monetary policy — could be important to a state’s capacity to win civil wars for two reasons. The first is that, when you’re burning the economic candle at both ends, it helps to have financial help from outside the country, often in the form of foreign loans. When foreign financiers are looking to make loans to a country, an independent central bank is one of the first things they look for. They absolutely love it. When they see that a country’s money supply is being managed by fellow financial professionals with no accountability to voters and a mandate to favor stability and paying down debts over economic growth, their eyes bulge and turn to dollar signs and their hearts start beating out of their chests – it’s really something to see. The point is, they’re more likely to make the loans, which in turn means states are more likely to have the money needed to win the war.

Related: How do ‘whole-of-government’ programs actually work? Part II

The second is that civil wars are often, at least in part, actually about the economy. A country where the elected government controls monetary policy might be tempted to print money to cover the cost of a war. Such a plan would work for a while, but (with apologies to the Modern Monetary Theorists among us), in most cases, it would eventually lead to inflation. Rising costs of goods might add to people’s grievances against the government, leading to greater power for the insurgents. Therefore, Garriga hypothesizes, central banks that are independent and as a result better able to resist the urge to drive up inflation may help shorten civil wars by limiting the level of popular grievance available for regime opponents to exploit.

To test her theories, Garriga ran data on 145 civil wars that took place between 1975 and 2009. For each conflict, she measured the independence of the state’s central bank on 16 legal attributes, including things like how the bank governors are appointed, how long they serve, and their level of control over monetary policy. Using that measurement, she gave each central bank a central bank independence score between zero and one in each year of the conflict. Comparing the two, she found strong evidence for a relationship between central bank independence and conflict termination. According to her data, going from having a central bank totally controlled by the government to one totally independent (going from zero to one in central bank independence score) makes a country 525% more likely to see its civil war end in a given year. Not only that, but it makes the war ending in a state victory also much more likely.

The mechanisms Garriga proposes also seem to hold in the data. Countries with independent central banks do get better deals from international financiers on loans — lower interest rates, with more time to pay them back – than their less independent counterparts, even if both regimes are under threat from internal rebellions. In addition, inflation really is lower in countries experiencing civil wars when they have independent central banks. Garriga argues that these results highlight the importance of international financial transactions to local conflicts. Many have pointed out, as Garriga notes, that austerity measures associated with the conservative monetary policies often pursued by independent central banks might constrain a country’s ability to raise funds to fight a civil war. Yet, she notes, it appears that the benefits of accessing international finance outweigh the costs of limiting domestic spending, at least when it comes to the ability to repress internal rebellion. Left unsaid is the potential role austerity policy can plan in generating the kinds of grievances that set off civil wars in the first place.

Critical State is your weekly fix of foreign policy without all the stuff you don’t need. It’s top news and accessible analysis for those who want an inside take without all the insider bs. Subscribe here.